Apple faces tough choice on cheaper iPhone

Zombie-like in its persistence, talk of a cheaper iPhone again shuffled into view this week, with sources as varied as the spotty DigiTimes to the more mainstream Wall Street Journal and Bloomberg claiming Apple will enter the low-price fray this year.

Such a move would be a major strategic shift for the company, and put at risk its biggest money maker: During the last reported quarter, the iPhone accounted for 48% of the company's total revenue.

Some analysts weren't biting on the new speculation, perhaps remembering, "Fool me twice, shame on me," while others believed that the smartphone market is different enough today that Apple has to be thinking of going low.

"This will eventually happen, but only when Apple feels that it's the right time and that it is able to do it," said Ezra Gottheil of Technology Business Research. "But not this year. I don't think they're ready for it now."

Jack Gold, principal analyst at J. Gold Associates, disagreed. "Things are very different today. Samsung, for one, is kicking butt right now," said Gold. "Apple's share is decreasing, and they need to counter some of Samsung's momentum."

The latest round of speculation began Tuesday when DigiTimes, an Asian publication with an iffy record of accurate predictions, said supply sources claimed Apple would release a lower-priced iPhone for emerging markets in the second half of 2013. On Wednesday, the Wall Street Journal and Bloomberg, both citing unnamed sources, chimed in with similar accounts.

This week's speculation was in the same vein as earlier reports, which have circulated almost from the moment Apple introduced the iPhone in 2007 at prices starting at $599.

Accepting the new rumors at face value relies on certain assumptions about the notoriously-secretive Apple, its strategy, the increasingly saturated smartphone market and the subsidy model that keeps prices to consumers low.

"Once you have the high tier covered, how do you go after the mid or low tiers?" asked Gold. "They need to have something at lower price points."

Samsung, the Korean electronics giant which now dominates the Android smartphone market, is, in analysts' minds, Apple's biggest rival. And Samsung, as Gold pointed out, "has phones for almost everyone and every market, at all kinds of prices, from $49 to hundreds."

Meanwhile, Apple has relied on just one new main model each year, then bolstered its offerings by continuing to sell previous generations at a discount. "That helps," said Gold of the older models' lower prices, "but they're old, and not up to Android phones at the same price points."

In 2012's third quarter, Apple accounted for 15% of all smartphone shipments, up slightly from 13.3% in the same period the year before, according to IDC. Samsung's share, meanwhile, jumped to 31.3% from 22.7%.

Gold argued that Apple needs lower-priced new smartphones to stay competitive, to protect its decreasing share of the smartphone market, and to sustain its high rate of both sales and revenue growth.

"Apple needs to be more competitive with [rivals'] low-cost devices, particularly in emerging markets," Gold said. "They haven't done nearly as well from a market share perspective in emerging markets."

Apple and other smartphone makers have been able to keep out-of-pocket prices relatively low -- the iPhone 5 starts at $199 -- by convincing mobile carriers to heavily subsidize the hardware. A non-subsidized iPhone 5, for example, costs $649.

Neither Gold or Gottheil believed that large subsidies are sustainable over the long run, another reason why a less-expensive iPhone is not only smart, but eventually a necessity.

The subsidy wall already has one crack: In the U.S., T-Mobile plans to start selling the iPhone this year, but will not subsidize the phone. Instead, T-Mobile will tempt buyers with no-contract, unlimited data plans. A less-expensive iPhone would make T-Mobile's job that much easier.

Gottheil's biggest objection to a quick appearance of a low-priced iPhone didn't stem from a vastly different read of the landscape, but because he doesn't believe Apple could crank out more phones than it does now.

"I think Apple does want to have a larger share of the smartphone market," Gottheil said. "They don't want to be a specialized niche player. That almost killed them in personal computers. But I don't think they're ready to [introduce low-priced iPhones] now. They would have to have an entirely new supply chain with higher capacity."

Apple only recently managed to reach a balance between supply and demand for the iPhone 5, which went on sale in late September. Gottheil reasoned that a lower-priced iPhone, whose success would rely in large part on volume sales, would be beyond Apple's current production capacity.

Bloomberg said its source had pegged the retail price of a cheaper iPhone at between $99 and $149, but analysts dismissed that range as too low.

Brian Marshall, a Wall Street analyst with ISI, said Apple would be much more likely to price a new iPhone for emerging markets at an average sales price (ASP) of $300. "Basically half of current iPhone ASP," said Marshall. "The key is maintaining 40-45% gross margin, versus 50-55% gross margin on the iPhone 5."

Gottheil named the same $300 price point, but Gold figured if Apple went in for a penny, it would for a pound. "They have to hit all the price points," Gold said, noting three ranges: under $100, between $100 and $250, and above $250. "They could reduce the [manufacturing cost] by using a small display with lower resolution and lower memory," Gold added. "But there would be compromises."

Which may be the stumbling block for Apple. In the past, company executives, including former CEO Steve Jobs and current chief Tim Cook, have said they wouldn't sell devices at certain price points because they couldn't while maintaining product standards.

"Apple wants to remain a premium brand, with solidly-built devices and all the appropriate support services," said Gottheil. The company may eventually produce a less-expensive smartphone, but it would still be at what the analyst called "the higher end of the price band."

"That's necessary to maintain their margins and their high level of service, as well as their brand integrity," Gottheil said.

The aim would be to make the price difference between an iPhone and a low-cost Android smartphone "not so huge that it becomes a painful decision for consumers," he continued. "They'd like to narrow that gap."

Both experts pointed to the iPad Mini, the scaled-down tablet priced $170 under that of the full-sized iPad, as an example of how Apple would likely approach a cheaper iPhone.

But like the iPad Mini, whose sales some suspect have been at the expense of the iPad, there's potential cannibalization if Apple ships a lower-priced iPhone.

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